India: International Taxation

Development is a process that opens new avenues of trade and globalization. Indian economy is growing at an average of approximately 7% over last decade that led to the India becoming a global hub for various trade facilitations. India has signed trade agreements with various countries such as Comprehensive Economic Partnership Agreement [CEPA] with the UAE, Economic Cooperation and Trade Agreement with Australia, India-EU Board Based Trade & Investment Agreement [BTIA] Negotiations with the European Countries among others and expected to sign the same with Great Britain and many other countries in the near future.

The Cross-border trade amongst countries is growing at a much larger pace and many collaborations, joint ventures, and technology transfer are taking place in and from India. Therefore, it has now become imperative for the country to boost its policies and laws with respect to International Taxation in order to ease the business operations and flow of funds.

International Tax can therefore be defined as the body of legal provisions of different countries that covers the tax aspects of cross-border transaction, in other words, it is the study of Taxation beyond the National level¹ that covers the international aspects of an individual country's tax laws as may be applicable.

India is a developing nation with a fast-growing economy with the prediction to see a five-fold increase in economic value through digital transformation by 2025. Beside creating opportunities for global and local businesses, start-ups, and innovators, India with the aim of creating an efficient tax system, has expanded their tax base through digitization and e-governance. Where, it has been estimated by the International Monetary Fund (IMF) that the digital transformation will contribute to India's economic growth by improving access to global markets and enhancing the country's competitiveness. It expects digital technology to increase the ease of doing business, and to promote more cross-border trade.

The increase in Foreign Direct Investments (FDIs) is inversely proportional to the tax demands which would arise in numerous circumstances as a result of uncertainty in understanding the concepts of International Taxation. Therefore, it is crucial to understand the potential impact of national and foreign tax developments such as Free Trade Agreements (FTAs), Double Tax Avoidance Agreements (DTAA) and tax associated with technology transfer so as to prepare oneself for the challenges that may arise in the future.

However, before we get into the aspects of International Taxation, it is essential to understand the difference between domestic normal tax as applied to a resident and the foreign tax as applied to foreign companies having their branch office or wholly owned subsidiaries in India.

THE INDIAN TAX SYSTEM

The Indian Tax system is well structured and has a three-tier federal structure consisting central government, state governments and local municipal bodies. Here, there are two types of taxes that is levied in the country –

1. Direct taxes – which are levied on the earnings.
2. Indirect taxes – which are levied on expenses.

For the purpose of the taxes levied on corporate entities and individuals it is pertinent to focus on Direct Taxes. For taxpayers, there are three kinds of Direct taxes that needs to be considered, this includes –

1. Income Tax
2. Capital Gains Tax
3. Corporate Tax

The most important type of Direct tax is the 'Income Tax' which is levied during each assessment year (1^st April to 31^st March). It applies to the income of a company or an individual according to their residential status. Here, residential status and scope of total income can be found under Section 6(3) of the Income Tax Act of 1961.

As per this section, a company is said to be a resident in India in any previous year, if:

i. It is an Indian Company; or

ii. Its place of effective management or P.O.E.M., in that particular year is in India. P.O.E.M. can be understood as a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance, made.

However, this clause is not applicable to companies with turnover up to INR 500 million in a financial year.

The provision related to the residential status can therefore be understood in the table below –

Furthermore, to understand the difference between a resident and non-resident company, Section 2(30) of Income Tax Act 1961, defines a Non – Resident.

The section refers to a person who is not a resident of India i.e., who does not ordinarily reside in India. Therefore, as mentioned above, the non- residency of entities is computed based on their place of incorporation or Place of Effective Management or P.O.E.M.

Therefore, for a resident Indian company, the global income is taxable in India. This income may have been earned or received outside – but it shall be taxed in India. However, if the income is also taxable in another country, there are in place 'Double Taxation Avoidance Agreements (DTAAs)' between countries to avoid paying taxes twice on the same income.

Currently, India has DTAA with more than 110 countries. However, to consider the application of DTAA, it is essential to understand the meaning of double taxation.

DOUBLE TAXATION

With the increase in global trade and cross border transactions, the effect of taxation on such transactions plays a vital role in determining the tax routes domestically in every country. The accrual of income in one country increases the obligation of tax liabilities. In situations where the entity is registered in one country and the income accrues or arises in another country, there is probability of double taxation for the business. One of the most significant results of globalization is the visible impact of domestic tax policies on the economy of other countries.

Double taxation means taxing of the similar invoice twice for the assessee. The income of an assessee to be taxed based on his residency and also in a different country is based on its' source of accrual. This may lead to double taxation and eventually be a cause of issue for the taxpayer. The Income Tax Act 1961 has discussed and provided relief for the double taxation regime.

1. Bilateral Relief – Section 90 of Income Tax Act, 1961 – Agreement with foreign countries or specified territories.

In this, the governments of two countries enter into an agreement to provide relief of double taxation by mutually working in favour of the businesses in each country. Indian government has entered into more than 85 tax treaties with countries to promote globalization and avoidance of double taxation.

An entity to claim tax relief needs to have a TRC (Tax Registration Certificate) issued by their home country. The DTAA (Double Taxation Avoidance Agreements) clearly states the areas for income generation with respective tax rates and procedures for claiming refund of additional taxes paid, or avoidance of double tax. However, nothing withstanding elaborates about the evasion of taxes.

Bilateral Relief may be granted either based on Exemption method (i.e., taxation of income in only one country) or Tax Credit method (i.e., tax credit is claimed from home country on doubly taxed income).

2. Unilateral Relief – Section 91 of Income Tax Act, 1961 – No Agreement with a country.

The home country provides taxation relief to the resident assessee, even when no DTAA has been with the country. The country usually has a Free Trade Agreements (FTAs)² or the assessee discloses in his Income Tax return the chargeability of dual taxes based on which claims refund.

According to Section, the Central Government has imposed conditions to be fulfilled prior to claiming Unilateral relief, such as:

a. Assessee must be a resident of India in Previous year when income is taxed.

b. Income accrues or arises outside India.

c. Income not deemed to be accrued or arise in India.

d. There has been an Income tax liability on the Income in foreign country.

e. Income tax has been paid in the foreign country.

f. There is no relief agreement between the two countries.

Based on the fulfilment of the above conditions, the Central government of India along with tax authorities allows the refund as per the tax rate applicable in India or the other country, whichever is lower.

Advance Rulings

A taxpayer can understand the scope of his/her proposed transaction prior to actual commencement by approaching the Authority for Advance ruling with the aim of understanding the scope or legalities of the transactions or proposed transactions.

According to Section 245N(a) of Income Tax Act 1961, Advance Ruling is a written opinion or authoritative decision by an Authority empowered to render it with regard to the tax consequences of a transaction or proposed transaction or an assessment in regard thereto. [3]

The applicant may make an application to the Principal Commissioner or Commissioner concerned with the questions raised. The Advance Ruling is binding only on:

• Applicant who had sought it.
• In respect of the specific transaction in relation to which it was sought.
• On the Principal Commissioner or Commissioner and the income-tax authorities subordinate to the Principal Commissioner or Commissioner in respect of the applicant and the said transaction.

The person not satisfied with the opinion or remark of the Authority of Advance Ruling may further report to Appellate Authority of Advance Ruling.

E COMMERCE and TAXATION

E-commerce is a fast-growing market with a wide scope. The fact of Digitalized world has been in a boom and the whole world now is a part of Digitalization. The benefit it has been for the countries to adopt digitalization, the hectic it has been for the respective countries to impose taxation. Digitalization makes it difficult and complicated for the country to detect the resource and source of income earned.

The digital economy of India has grown up to 10.2% of total GVA.

To remove the complexities in detecting the nature and location of income earned by taxpayers, the CBDT (Central Board of Direct Tax) constituted a committee to address the challenges arising on taxing the digital economy. Chapter VIII of the Finance Act, 2016, titled "Equalization Levy" has been introduced which provides for an Equalization levy @6% of the amount of consideration for specified services received or receivable by a non-resident not having Permanent Establishment in India, from a resident in India who carries out business or profession, or from a non-resident having Permanent Establishment in India, and Equalization levy @2% of the amount of consideration for E-Commerce Supply or Services. The threshold limit for deduction of the aggregate amount of consideration for specified service in a previous year exceeding one lakh rupees.

CONCLUSION

India is quickly emerging as a major player in the global market and has taken many initiatives to diversify and expand its' business prospects. The increase in trade activities if directly proportional to the obligation of taxation. The concept of international taxation has eased the business, whereas the source of income generation has clarified the complications pertaining to non-resident tax obligations thus, preventing the tax base erosion and profit shifting strategies of entities. As a consequence, the Revenue Authorities of India has also expanded their tax base through digitization and e-governance.

Footnotes

1. https://taxguru.in/income-tax/study-international-taxation.html

2. A Free Trade Agreement is an agreement between two or more countries where the countries agree on certain obligations that affect trade in goods and services, and protections for investors and intellectual property rights, among other topics.

3. https://incometaxindia.gov.in/pages/international-taxation/advance-ruling

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.